Inside Business Sunday 29 September

ALAN KOHLER, PRESENTER: Telstra should take over the NBN, especially if it is not going to be monopoly.

As it is now, the Government is basically renationalising Australia's fixed line communications infrastructure, having sold it to Telstra shareholders in three lots between 1997 and 2006.

And it's doing it by building an entirely new fibre network and then buying Telstra's customers, as well as renting access to its pipes and ducts, all for $11 billion. So its customers are switched over to the fibre, the copper gets switched off and Telstra gets paid.

Well, the new Government has said that's too expensive and too slow, so they're going to keep some of the copper instead.

But selling copper to the NBN Company at the time as the fibre is rolled out and customers are persuaded to switch, will be a nightmare. Far better either for Government to buy the whole copper network all at once, to build the NBN as a joint venture with Telstra, or sell the whole thing to Telstra.

Now the first item would involve the Government actually renationalising Telstra's entire wholesale division as an operating business, unlikely with the Coalition, and too expensive. A joint venture is probable but difficult, and anyway Telstra would end up running with the Government pouring in money. And where would the political buck stop?

Far better for the Government to sell the NBN to a structurally separated Telstra. That is, to a separated Telstra wholesale division. The Government's no good at these things anyway, as Malcolm Turnbull keep pointing out.

And if it is not going to be a monopoly, what's the point of the government owning it? And now's the time to make the change, since Mr Turnbull is searching for new management for the NBN. And by the way, the word is he's looking to poach someone from Telstra because they know how to build networks.

Telstra was going to build a national fibre to the node network five years ago, but the Labor government banned them from the process because they didn't like Sol Trujillo. So just let nice David Thodey finish the project and then hive it off as a separate listed company.

Ok, enough about the NBN. Let's talk about property. And Saul, is the property market getting into dangerous territory? You've been looking through the evidence. Take us through it.

SAUL ESLAKE, ECONOMIST, BANK OF AMERICA, MERRILL LYNCH: I don't think it is in dangerous territory yet. I certainly wouldn't use the phrase bubble. One of the hallmarks of a bubble is not just rising prices but rising level of leverage and debt in, and, in aggregate at least, we don't have that at the moment. The total stock of mortgage debt outstanding has risen 4.7 per cent over the last 12 months. That's less than the increase in house prices.

But lower interest rates are certainly stimulating some activity in the housing market and the first of the charts we've got here shows that auction clearance rates are running at about 70 per cent, higher than that in Sydney, that's the highest since May.

ALAN KOHLER: I think they're at 84 per cent in Sydney.

SAUL ESLAKE: That's right, close to 90 per cent in some press reports have said. That's certainly the highest since house prices were rising very rapidly in the year after the GFC. If we look at house prices themselves, we can see that across the eight capital cities, house prices are up by 7.5 per cent from their low in May 2012.

Again, the increases have been bigger in Sydney and Perth, less in Brisbane and Melbourne, but overall, 7.5 per cent's about three times the inflation rate. So certainly something happening on the price front yet, not alarming, but deserves to be watched.

I think the key thing about this recovery is that it's being disproportionately driven by investors. This chart here shows that investors have accounted for 60 per cent of the increase in lending for housing over the last 18 months or so, and that's well above their share of the stock of loans outstanding, which is about 40 per cent and rising. And the issue with that, which the final chart brings out, is that only six to 8 per cent of investors buy a new house historically, or apartment, as opposed to 20 to 25 per cent of its owner occupiers.

So recovery in housing induced by loss interest rates that's disproportionately driven by investors, as this one so far has been, is likely to do much more than push up prices and less to induce new construction that either the Reserve Bank wants or the country needs. And that means that although we don't have to push the panic button or sound the alarm at the moment; this is something that requires careful monitoring and in my view we should be prepared to ache some action if a year or so down the track.

ALAN KOHLER: Yes, like what? What action?

SAUL ESLAKE: Well there are a number of actions that could be taken. I would say, for example, since this is being driven disproportionately by investors and investors benefit mightily through what we in Australia call negative gearing, that a first best option would be to get rid of negative gearing. Politically that's...

ALAN KOHLER: I might hold you there. What about you Mike, are you against negative gearing, as Saul seems to be?

MIKE MANGAN, 2MG ASSET MANAGEMENT: I think its a political pipe dream, isn't it? It's impossible to get it through and stay in government.

JOHN DURIE, THE AUSTRALIAN: That's true. But I think in concept I think Saul's right. I think, it doesn't, it's not a rational policy when you think about it.

ALAN KOHLER: Maybe they should do something with the risk weightings in banks, so that that restrains the bank in the way they lend?

JOHN DURIE: Well in my view we ought to start with self-managed super funds. There's a loophole there which allows property spruikers to run merry and self-managed super funds are just making out like bandits through this and thinking they're all very clever.

ALAN KOHLER: Bandits?

JOHN DURIE: That's right.

ALAN KOHLER: We've got a chart of what the self-managed super funds are doing in property. Here it is. It's the DIY super property assets. Total, as you can see, is rising. But look, it's all in commercial. Residential is not that much so far as least. The commercial property investment by self-managed super funds is all in the business owners buying their own factory, or their shop. That's what that's about. Maybe you're saying it will get out of hand, but you have to say it's not yet.

JOHN DURIE: I take, I concede that issue. I'm just worried that the system is open to abuse. Maybe that's the loophole we could shut.

ALAN KOHLER: What do you think, Saul?

SAUL ESLAKE: Well I'm surprised that superannuation funds have been allowed to gear since June 2007, I gather that change was made. I think that introduces an unnecessary element of risk into what's supposed to be about building security retirement nest eggs with considerable support from taxpayers.

But if I could just take the argument back to the proposition about individual investors, because they are the ones who are driving this investment recovery, it is not institutional money like it is in the United States. And here in Australia we have a situation where one in every six taxpaying Australians is a landlord because of negative gearing.

I take the point that it is politically unrealistic to knock it off, but what you could do, for example, is say from this date forward negative gearing will not be available for new investments, or you could say it will only be available for investments that involve the construction of new dwellings, so that you give an incentive to boost supply.

If neither of those things are possible, then I think we really do need at some point to be looking at the examples that have been set by Canada and New Zealand over the last 18 months.

In Canada the authorities have mandated a reduction in the maximum term of mortgages from 25 to 20 years. That's a way of increasing repayments without increasing interest rates, which you certainly wouldn't want to do in the present environment, given how weak the non mining business sector is.

Or alternatively if we don't want to do that, then not now but down the track we might have to look at copying what the New Zealanders have done, which has been to limit the number of low deposit or high loan to valuation ratios loans that the banks can make and or require the banks to hold more capital against high LVR loans, which would inevitably mean the banks would charge higher interest rates on those loans and help discourage them.

ALAN KOHLER: I think Saul, you've just sparked an absolute rush into negatively geared investment property, just in case the Government does it in future. But we'll have to move on. It's fair to say the nation's biggest residential developer, Stockland, has not been experiencing bubble-like conditions. I spoke to Stockland chief Mark Steinert about what he's seeing in the market.

Mark Steniert, last year your residential division saw a 14 per cent decline in lots sold and a halving of the return on assets, yet you've just launched your biggest ever residential development, Willowdale in south west Sydney, so does that mean that you think that business has now turned around?

MARK STEINERT, CEO, STOCKLAND: That's fair way of describing it. I mean, certainly 13, that was a challenging year for the company but we're very pleased that we now have projects like Willowdale coming to market at normal margins and we see them as a key part of our growth strategy moving forward. And we are, as you say, convinced that the market has turned around and will continue to grow from here.

ALAN KOHLER: There's been a lot of commentary that low interest rates are causing prices to rise but not leading to a lot of house building, so does Willowdale also suggest that you think that's changing?

MARK STEINERT: You go back two and a half months ago and we really saw below average levels of first home buyer activity, that's now changed and has been consistently stronger over that period, together with the up-graders and the down-sizers and the investors. They're all now in market and that broadening of market is very important.

To your point about looking at the building approvals, there's always going to be a lag. I mean, we're selling land for future homes and typically six to nine months before those homes are going to be coming out of the ground and coming to completion.

ALAN KOHLER: The other thing that happened in your residential division last year was a collapse in the profit margin from 15.6 to 6.6 per cent. Now you've said that by 2016 you expect to get the margin back to 11 to 13 per cent, but do you think it will ever get back to 15 per cent or more?

MARK STEINERT: Yes. The improvement to 11 to 13 is really reflecting over that period of time that the number of impaired lots that we will be selling will gradually decline, and at the same time bringing on key new projects like Willowdale, Marsden Park, Banjup in Perth, Pollara in Queensland and Davis Road in Victoria - and they're all at normal profit margins in terms of EBIT and internal rates of return.

They're the key growth engine, together with the rest of our portfolio, particularly the shopping centres which are also performing well above their peer group.

ALAN KOHLER: I had an impression that Stockland itself was shifting from young first home buyers, that is to say residential developments, to older buyers in retirement villages because they're the only ones who can afford houses these days. Is that trend also reversing now?

MARK STEINERT: Look, we certainly have got a retirement living strategy as part of our growth platform, and we're one of the largest operators of retirement villages in Australia; over 8,000 independent living villas. But at the same time more than half of the 5,000 odd lots that we sell a year are going to first home buyers, people starting their families for the first time. Generation Y is at a point now where they're definitely having to make that family formation decision.

And also, migrants coming into the country, they're typically classified as a first home buyer also, and with 180,000 migrants a year coming through, that's a key part of the ongoing demand for housing as it is a key driver for the broader Australian economy.

ALAN KOHLER: I also noticed that the retirement village business suffered a price decline of 2.3 per cent, what caused that? And is it tempering your optimism about that business?

MARK STEINERT: What caused it was the preceding weakness we saw in the broader housing market. You know, the retirees need to typically sell their existing home to move into a retirement living villa, and so the weakness in the broader housing market that we'd seen in prior years was really the key driver there. And that was a reduction that was reflected in the first half, pre-December 2012, and what we've seen since then actually is a little bit of price improvement and certainly our retirement living business responded first to the broader improvements that we saw in the housing market.

The housing market has seen a sequential recovery through FY (financial year) 13. It started early in the year with investors, typically "do it yourself" super and off-shore buyers coming into Australia, then you saw up-graders and down-sizers and then as I mentioned in the last few months you've seen the first home buyers, which is incredibly important.

The thing about the first home buyers being active during an election campaign you know when a lot of other things actually stalled, suggests that there's a fairly high degree of confidence in people's job prospects.

So while the cities have been a little bit challenged I think the metropolitan area generally is seeing reasonably robust economic activity and a lot of these industries are Australian dollar sensitive, so that's another plus.

ALAN KOHLER: How much further do you think the housing market can run, and are you concerned about there being a bubble as some people are?

MARK STEINERT: At this point, I'm definitely not concerned about a bubble. I mean the inner Sydney market is pretty hot, and inner city markets generally have strengthened considerably. And that's all about supply constraints, and you are seeing apartments and high density coming in to address that demand in a lot of the capital cities, particularly in Sydney and Melbourne and Brisbane. So I think that will even see some tempering, I don't believe that's going to create falls in values, but it will certainly temper the rate of increase.

I would suggest in a lot of the metropolitan locations, the issues have been around pent-up demand, and certainly in Sydney, under-supply and Perth also to some extent. Governments have worked pretty hard to change that, to fast-track urban growth corridors, to line that up with infrastructure, road and rail, education, and do that in the context of community requirements but also to be pragmatic in that approach. And that ...

ALAN KOHLER: Are they doing that fast enough?

MARK STEINERT: Yes, I think things have changed quite dramatically. I mean Willowdale, from when we acquired that land, to bringing it to market; we're looking at three years. If you'd gone back to latter periods of time, say seven to ten years before that period, it would have probably taken us ten years to bring that to market. So we've seen a dramatic, you know improvement.

ALAN KOHLER: With your commercial property division you've got a finger on the pulse of the business sector, retail, office and industrial. What's going on there?

MARK STEINERT: Good question. It's mixed, it's been pretty difficult it's fair to say and if you take the last 12 months in retailing, retails sales have been quite subdued.

Having said that, we've seen sentiment improve from consumers and business in terms of the surveys in August. We've seen our numbers starting to show some green shoots.

If we're seeing new homes being built, as people move into new homes that obviously drives shopping as well.

Office, that's been pretty tough. Typically you've seen companies down-sizing, looking to do off-shoring and out-sourcing and reduce costs. A lot of that seems to have passed, and you know I think you could see a way forward where confidence there will also improve, you know, the levels of investment are at historical lows relative to GDP, and something will have to give but at the same time, that transition normally takes a little bit of time to read through.

In distribution warehousing, same thing. With retailing being flat, given most distribution warehousing users are logistics, dedicated logistics or the back function for the retailer themselves. Demand there has been flattish, although supply has been constrained. And once again we've started to see an uptick in activity there as well.

ALAN KOHLER: Thanks a lot for joining us Mark Steinert.

MARK STEINERT: Thank you Alan, really appreciated.

ALAN KOHLER: Mike, I suppose you'd call the retirement village market the last home buyers, and the, it's interesting to see them move back into the first home buyer market. Obviously there's a bit of optimism there.

MIKE MANGAN: The critique I would make is that their land tends to be a long way out from the city. Willowdale and whatever, and I know they've got big tracks of land up at Caloundra. People want to move close to the city. There's a trend, there's a long term trend of moving back into the city.

Just as an example, in the US cities, for the first time, are growing faster than the suburbs, for the first time since the 1920s. And there hasn't been a new shopping mall for example built, an enclosed shopping mall built in the US since 2005. People want to go back into the cities. So that's ...

ALAN KOHLER: You live in Sydney. How hot is the market there, in the inner suburbs as Mike Steinhert was talking about?

MIKE MANGAN: I think it depends where you are. Lower North Shore, it's just starting to improve. I think in the other inner cities it has been on the rise for a while. It depends on the price point, I think.

That's the critique I would make about Stockland. I think Mirvac's probably got some property that's a bit closer to the city. I know they're developing Harold Park, which is very close. So I think, Mirvac generally has been more sought after in the market.

ALAN KOHLER: What do you think, Saul?

SAUL ESLAKE: I think what Mike just said there underscores the importance of urban infrastructure as contributing to improving the supply of housing. I agree with the point that Mark Steinert made in the interview there before, what we really need to see is more new housing coming on to the market to meet that increase in demand that he identified as coming from migrants and from Gen Y getting to the family formation stage. That's why our house prices are so flat. That's why we have a housing affordability problem in this country.

ALAN KOHLER: And John, the infrastructure has been held back? They've just not really been encouraging the supply in the outer suburbs.

JOHN DURIE: Sure. Clearly, infrastructure is a national problem. I think maybe we're being a little bit too gloomy. To me this story is promising too. It's showing that things are starting to get going. We've had for a long time everyone has been doing nothing. But now we have some investment going and that's surely a good sign.

ALAN KOHLER: And you've got to hand it to the United States as innovators. Just when you think they've run out of crisis, up pops the debt ceiling again, which could see the Obama administration apparently run out of money in a couple of weeks, October 17 to be precise.

Treasury secretary Jacob Lew is calling it a catastrophe in the making again.

JACOB LEW, U.S. TREASURY SECRETARY: No treasury secretary and no president ever got to the point where we actually ran out of the ability to borrow, and it is unchartered territory in the sense of people have thought about what they would do, but they have never had to cross the line. It is not a line we should cross.

There is no plan, no plan after we run out of borrowing authority that will give us the ability to meet all the obligations of the United States.

ALAN KOHLER: They'll do a deal, won't they? They'll have to before that time.

SAUL ESLAKE: That's certainly been the precedent set in recent examples. Think the fiscal cliff at the beginning of this year, the almost breaching of the debt ceiling back in August 2011 and I think the lesson of that history and going back to the standoff between Bill Clinton and Newt Gingrich in the mid 1990s, is that the party which is seen as by the public as precipitating a shutdown of government loses big time in the political space.

I think the Republicans probably feel that they need to push this right up to wire in order to maintain faith with their supporters. But if they go over wire they'll pay a big political price, and in the end I don't think they'll do that.

MIKE MANGAN: And I think that's what the market assuming, I think, that this will sort itself out. Of course if it doesn't, there will be a panic.

ALAN KOHLER: When Saul referred to the Clinton-Gingrich standoff in the mid 90s. In the month that it happened the stock market fell 3.5 to 4 per cent. The following month it went up 10 per cent.

MIKE MANGAN: Yes.

ALAN KOHLER: So it fully recovered. Everything was fine. Likely to happen this time.

SAUL ESLAKE: The risk might be with another rating agency matches what Standard & Poors did in August 2011, last time we had this debt ceiling standoff and downgraded the US from AAA again, many other agencies, other central banks who hold US dollars have been able to do that because there's still AAA rated by two agencies.

If Moody's and Fitch decide to follow S&P because it gets that close to the wire, then maybe there could be some ructions in the currencies markets. That's of course another good reason for assuming, as Mike said, that markets are doing that, in fact the Republicans will push it close but not that close.

ALAN KOHLER: Meanwhile the underlying economy seems to be doing okay.

Both China and Europe reported pretty solid efforts by the manufacturers. These are flash PMIs, purchasing manager indexes, above 50; which means activity is expanding rather than contracting. In China the reading is at in fact a six month high.

So Saul, at this stage at least PMIs are showing the economy is improving.

SAUL ESLAKE: Yes. These are good figures. I actually think the correct way to interpret these PMIs is not if it's above 50 manufacturing is expanding, if it's below 50 it's contracting. I mean clearly Chinese manufacturing activity has not been contracting over the last six months when the PMI has been in the high 40s.

Rather what it means is that it's been growing below trend when the number is below 50, and the most recent reading says that manufacturing activity in China is growing above trend, at least for the moment. That's good for our resources sector, it helps explain why iron ore prices have been remarkably resilient, and probably will be for at least another month or so.

The newer development I guess is that Europe's manufacturing sector is now showing signs of growing at an above trend pace after some two years of growing out of below trend pace. And if Europe can contribute positively to the world economy then that's a very good thing indeed.

ALAN KOHLER: John, are we seeing resource stocks starting to respond to this?

JOHN DURIE: We are. Obviously, they've underperformed for a long time, but they're starting to bounce a little bit, which as Saul says is good news. Just how far, who knows.

ALAN KOHLER: Mike, you've got a graph showing exactly how resource stocks have underperformed, and what's been happening lately. Show us that.

MIKE MANGAN: This graph will show you that they reached a bottom, I suppose, in June and they've bounced slightly since June.

ALAN KOHLER: This is relative to industrial...

MIKE MANGAN: This chart shows you the all resources divided by the all industrials. So the all resources have underperformed until June.

ALAN KOHLER: Massively, look at that.

MIKE MANGAN: Massively. Macquarie, about six months ago thought that the underperformance was the worst since 1986. As you can see it's only bounced a little bit.

So the fact, and that's led to dreadful sentiment towards the sector. Constant downgrades for at least a year. Now you've, just in the last week or two you've seen the PMI in China that's suddenly popped up when everyone was expecting it to continue to fall.

You've got steel production in China up 14 per cent on the month. I think that there's an opportunity here and I think you'll find that resources will kick on from here. If for no other reason, as sort of a rebound from the dreadful sentiment that we've seen.

ALAN KOHLER: BHP announced their pay this week. They all got pay cuts, didn't they?

JOHN DURIE: They did, which was a good thing. But BHP actually, as a governance concern, ran it very well. The point was they outperformed their index, but their total shareholder return was negative. The board said I'm sorry, you've all got to take a pay cut. They still did okay.

ALAN KOHLER: Yes, they're not going hungry.

JOHN DURIE: They can still afford to pay the rent, I think.

ALAN KOHLER: That's right. There have been a few other developments in the corporate world in the week.

We had David Jones post a 6 per cent slide in profit, although it was better than expected, underlying earnings were up, CEO Paul Zahra isn't banking on an immediate improvement though.

PAUL ZAHRA, CEO, DAVID JONES: We said the fiscal 14 will continue to remain challenging. I think until the government enunciate their policies, I think there is still a level of uncertainty. We expect fiscal 15 obviously to be a better year based on what we know today.

ALAN KOHLER: We had pre-election uncertainty causing retail sales to decline, now we've got post election uncertainty because we don't know what the new government's going to do. And in fact Joe Hockey's deferred the MYEFO (mid-year economic and fiscal outlook), so it doesn't interfere with Christmas sales.

But really everyone's going to think it must be really bad.

SAUL ESLAKE: Well it is a curious decision. The Government's within its rights to hold off MYEFO until the end of January under the Charter of Budget Honesty, although no government of either political persuasion has waited that long before.

From my lights, and I don't know what's going to be in the MYEFO, but if on the assumption, reading through between Joe Hockey's lines that it's bad, it is just as likely that consumers will respond to news that he's decided to put it off until after Christmas by saying, "What does he know that we don't? It must be awful. Therefore, I won't spend as much in the lead up to Christmas."

As it is that they will say "Oh phew, there's no bad news out, I'm going to spend up big this Christmas for the first time in three or four years." I mean it's, presumably some political strategy behind this, but the economic logic of it isn't apparent to me at least.

ALAN KOHLER: Well John, they've put out the budget outcome for 2012-13 on Friday, which of course was bad.

JOHN DURIE: It was bad but we knew it was going to be bad. I agree with Saul. I mean I think economically it's bad, but politically it is stupid too. I think we're all sort of jumping at shadows a bit. The momentum in real estate, I'm sorry, in retail was no one's shopping until we get the election result and I think everyone was thinking ok, once the election is going to be we're all going to race out and shop.

Well that was nonsense. We've had Myer and David Jones telling us that. And so we're going to, I think we've all got to just relax and things will get better.

ALAN KOHLER: What do you think Mike?

MIKE MANGAN: I think the department stores have been doing it tough as a category. There are other companies like Kathmandu, for example, that came out with good results during the week. The Reject Shop is another one. It's certain categories are doing well and department stores as a whole are under a lot of pressure. I'm not sure how soon that's going to change.

ALAN KOHLER: And John, a bit surprising that David Dearie of Treasury Wine Estates got the boot this week.

JOHN DURIE: It was an extraordinary decision. It was sort of eerie about three or four years ago Fosters, the predecessor company, did exactly the same thing. David Crawford was the chairman and he sacked Trevor Hoy and put in one of his own directors to run the company and then they split it up.

This time the chairman has sacked the chief executive. What happens next? That's the position we're in now.

There's some speculation that they'll sell the US. No one knows because no one knows what he did wrong. Paul Rayner, the chairman, went out of his way to say he's done nothing wrong, so why did he do it?

ALAN KOHLER: They're probably going to split it up. They're probably going to split the company and sell the US.

JOHN DURIE: That's the theory.

MIKE MANGAN: I think they can't sell the US at the current book value, I think that's one of the issues.

ALAN KOHLER: Not they can't at the book value, but they can, I mean the market's got the US business in Treasury Wine Estates at zero, wouldn't they? I mean...

MIKE MANGAN: Not zero.

ALAN KOHLER: The market's not paying any attention to book value, are they?

MIKE MANGAN: No, but if they sell and they've got to take another impairment charge, that looks bad.

JOHN DURIE: Well the assumption was private equity was going to buy this out of Fosters, so maybe they do it now.

SAUL ESLAKE: Well I think it's as close to certain as these things ever are that the Reserve Bank will leave rates on hold at the new low of 2.5 per cent.

The interesting thing will be the final statement as to whether they retreat even further from leaving the door open to another rate cut and whether they say anything about the property market that we were discussing at the top of the program. The minutes of the September meeting do show that they were paying some attention to the increase in investment by SMSFs in the property market.

ALAN KOHLER: The property market probably means they won't, do you think it means they won't cut again?

SAUL ESLAKE: I think it does. The thing that might have prompted them to cut was the rebound in the Australian dollar. It must be very frustrating to the Reserve Bank that every month for the last six months they've said please mark down the value of the Australian dollar. It's too high. And nothing happened.

Then when the Fed decided not to taper earlier this month, the Australian dollar bounced up by almost four cents. Some of that's come back, it's now around 93 cent, but that's still a lot higher than the Reserve Bank will want to see

ALAN KOHLER: And that's all, we'll have to leave it for this week. If you'd like to check out the program again or the full interview with Mark Steinert, it will be posted on our website later.

And thanks to our guests, John, Saul and Mike. Thank for your company. We'll see you next week.